February 13, 2009
Henry Fund Research
Consumer Staples (Food & Beverage)
Monty Piyush Gupta
Monty-gupta@uiowa.edu
Dow Jones US Food and Beverage Index (DJUSFB)
Index Value
52-Week Range
1-Yr % Change
Major Players by Market Cap (B)
Coca-Cola Co (KO)
PepsiCo Inc (PEP)
Kraft Foods Inc (KFT)
General Mills Inc (GIS)
Archer Daniels Midland Co (ADM)
Kellogg Co (K)
HJ Heinz Co (HNZ)
Campbell Soup Co (CPB)
ConAgra Food Co (CAG)
Sara Lee Corp (SLE)
Coca Cola Enterprise Inc (CCE)
Bunge Ltd (BG)
JM Smucker Co (SJM)
Important disclosures appear on the last page of this report.
Investment Recommendation: OVERWEIGHT
INVESTMENT THESIS

The consumer staple industry and the food and
beverage sector usually outperform the market in a
recessionary environment. The sensitivity of the
industry to performance of the economy is low.

The food and beverage sector was recession
resistant in 2008 and the trend will continue. When
the S&P 500 declined 40%, the Dow Jones US Food
and Beverage Index (DJUSFB) witnessed half the
decline, with only 20.73% fall. If the F&B companies
are removed from the S&P 500 list, the fall in the
S&P 500 will be much higher, magnifying the gap
between S&P 500 and DJUSFB.

Packaged food companies will benefit as consumers
will start eating more at home. The high
unemployment rate will also contribute to controlled
spending. Per USDA figures, food sales at grocery
stores totaled $500B in ‘08, up by more than 6% over
226.07 ‘07. The trend will continue in 2009.
207-298
Weaker overseas economic conditions present a
challenge for the F&B sector. However, in the long
59.11 (-20.73%) run, the demand from developing nations will
increase because of westernization and changing
eating habits, a growing middle class and increased
95 disposable income, and an increased demand for
79 nutritional packaged food.
37
Strengthening the US dollar is another challenge for
the companies with international exposure in the
19
industry as a stronger dollar means reduced
18 revenues from foreign operations.
16
Volatility in commodity prices is another problem. The
11 USDA’s ‘Index for Crop Prices Received’ moved from
11 158 points in Jan. ’08 to 183 points in June ’08 to 157
points in Jan. ’09. While the companies hedge
7 against volatility, reduction in commodity prices has
6 been a problem because of long-term commodity
6 contracts. However, because of the inelastic nature
of staples’ demand, companies manage to pass the
6 increased costs to customers.
5
In the short run, consumers will shift from premium
products to less expensive generic and in-store
brands. The long-term trends, however, will be a
continued demand for healthier food and beverages,
both domestically and internationally.
 THE UNIVERSITY OF IOWA
Henry Fund Research Henry B. Tippie School of Management

EXECUTIVE SUMMARY especially concentrated. In the carbonated drinks

category, the three largest beverage manufacturers—
The current recession in the US economy has led to a Coca-Cola, PepsiCo, and Dr Pepper Snapple—own the
37% decline in the S&P 500 in 2008. However, the brands that enjoy as much as 89% of the total market
consumer staples sector is one of the few sectors that share.
have outperformed the market.
The US non-alcoholic packaged beverage market
The major sub-sector of consumer staples is food and comprises of few key components. The largest sections
beverage. The Dow Jones US Food and Beverage are carbonated drinks (48%), bottled water (27%), fruit
Index (DJUSFB) has also outshined the S&P 500. The drinks (13%), sports drinks (4.5%), ready-to-drink teas
F&B sector declined only 20% against 40% of the S&P (2.8%), enhanced water (1.8%), and energy drinks
500. Because of its recession resistance, the sector (1%).
offers promising investment opportunities in comparison Packaged beverage industry
to other sectors in the economy.

The food and beverage industry is extremely

concentrated which is evident by the fact three large
carbonated drinks manufacturers enjoy 89% of the
market share. In contrast to many other sectors, the
leading national companies in F&B have strong brand
recognition. These companies manage to garner
manufacturing efficiencies and economies of scale by
focusing on large national and international brands.

In particular, the packaged food and beverage sector

will provide good investment opportunities because of
Source: Standard and Poor’s industry report
change in consumer preferences. In the current
recession market and increasing unemployment, RECENT DEVELOPMENTS
consumers will shift their food consumption from eating
at relatively expensive restaurants to eating at home, The food and beverage industry has been witnessing
thereby increasing demand for processed food. changes in consumer demand patterns that are shifting
from simple food products that satisfy physiological
At the national level, the entry barriers in the food and needs to products that have additional values, including
beverage industry are very high. The capital high vitamin content, organic food, supplementary
expenditure for production coupled with high marketing proteins, and energy food.
and distribution costs can be prohibitive for new
entrants. Top 10 publicly held food & beverage companies
(ranked on the basis on billion dollar of sales)
Company 2007 2006 % change
In the near future, the demand for expensive healthy
PepsiCo 39 35 12.3
and nutritional food products will be hit, which will offer
Kraft Foods 37 34 8.4
higher growth opportunities for less expensive and Coca-Cola 29 24 19.8
generic brands. Tyson Foods 27 27 (0.1)
Coca-Cola enterprise 20 20 5.7
INDUSTRY DESCRIPTION General Mills 14 12 9.7
Pepsi Bottling 14 13 6.8
The food and beverage industry comprises diverse Sara Lee 13 12 7.6
products: farm products, processed and packaged Dean foods 12 10 17.1
Kellogg 12 11 8.0
goods, meat products, dairy products, confectioneries,
Source: finance.Yahoo.com
soft drinks, and beverages from breweries, wineries,
and distilleries. However, we have considered only Therefore, most food and beverages companies are
packaged and processed food and soft drink beverages increasing their focus on healthy food products through
for this analysis. developing new product lines or acquiring popular
healthy brands.
The food and beverage industry in the US is highly
concentrated, with a small number of companies Also, an increasingly fast-paced life is motivating
enjoying a large market share. The beverage industry is consumers to demand faster food alternatives. In the

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Henry Fund Research Henry B. Tippie School of Management

beverage industry, this has made the demand for

energy drinks and non-carbonated drinks higher.

A few large players dominate the packaged food

industry. The entry barriers in the sector are steep, with
high costs of setting up plants, and high distribution and
marketing costs that will discourage many new entrants
in the sector.

The convenience of eating-on-the-go, double income

families, longer travel times, and increasingly busier
schedules has led to long-term trends of increased
dollar spending on food consumption outside of the
home. According to the US Department of Agriculture,
in 1960, US consumers spent 76% of their food dollars Source: usda.gov
on at-home food consumption. The number declined to While these prices declined in the second half of 2008,
53% in 2006. The increase in 2007 and 2008 can be the commodity market’s volatility has escalated
attributed to a weaker economy and higher food prices. problems for packaged food companies. These
companies can hedge against volatility in an elevating
Packaged food companies’ financial performances are price scenario; however, when the situation reverses,
less affected by sharp increases in raw material. This is the hedging activity can lock in food companies to a
because of the insensitivity of consumer demand to higher price for raw material.
price; producers can pass on the increased prices—
primarily from packaging, distribution, and marketing— Commodity prices stabilized towards the end of 2008
to the end consumer. The pie chart below showcases and in the beginning of 2009, which will relieve some
the cost structure at a typical packaged food company. pressure and help improve profitability in the coming
period.

In general, because of food costing more in stores, as

well as reductions in consumer spending because of
economic weakness, the packaged food industry will
witness two strong changes: an increase in at-home
food consumption, increasing demand for packaged
food at the cost of restaurant revenue; and consumers
moving towards the less expensive private labels.

Non-alcoholic beverages

A US decline in the sales of traditional carbonated

Source: Standard and Poor’s industry report
Between 2006 and 2008, commodity prices for corn,
wheat, and dairy products—all major ingredients in the
industry—jumped, placing additional pressure on
packaged food companies. The factors that led to
higher prices during this period included growing
foreign demand of packaged food due to changing
lifestyles and increased income, erratic global weather,
higher demand for grain (corn) for ethanol production,
higher energy prices increasing transportation costs,
and weakness in the US dollar.
drinks has prompted both Coca-Cola and PepsiCo to
introduce new non-carbonated drinks, ready-to-drink-
teas, energy drinks, and enhanced water. However, diet
soda continues to strengthen market share in the cola
category. Leading brands from Coca-Cola like Coke
Zero, Sprite Zero, Vanilla Zero, and Cherry Coke Zero
have seen increased demand and sales in 2008.
At Pepsi, while traditional Pepsi and Mountain Dew
continue to be the strongest brands, the company is
extensively promoting Diet Mountain Dew and Pepsi
Max—a recently launched diet formulation with caffeine
and ginseng.

Beverage companies are trying to pack more benefits,

like vitamins, into their products. In 2008, Pepsi
launched Tava—a zero-calorie cola that contains
vitamins. At the same time, Red Bull joined the cola

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 THE UNIVERSITY OF IOWA
Henry Fund Research Henry B. Tippie School of Management

industry by launching Red Bull Cola, which has higher because the domestic market is maturing and
caffeine content than Pepsi or Coke. becoming saturated. The future growth potential of
packaged food and beverages will come from
While the cola sales have been declining in the United developing nations because of the westernization of
States, most cola consumption growth is coming from eating habits, changing sociological settings, an
overseas markets. In 2008, foreign sales increased by increasing middle class, and rising incomes.
3% for Coca-Cola and by 11% for Pepsi. Both
companies will push their existing carbonated brands MARKETS AND COMPETITION
for higher sales in overseas markets.
The food and beverage industry is very concentrated,
In the juice category, beverage companies are with few companies having a major market share. In the
highlighting premium ingredients. Companies have packaged food industry, the largest players in terms of
launched juice products with more value adds like market capitalization are PepsiCo, Kraft Foods, General
added fiber and plant sterols. Mills, Archer Daniels Midland Co, Kellogg Co., HJ
Heinz Co., and Campbell Soup Co. In the beverage
Sports and energy drinks continued to gain popularity in industry, the largest players are Coca-Cola, PepsiCo,
2008. The growth of this sector can be attributed to and Dr Pepper.
increasing health consciousness and fast-paced
lifestyles. Consumers are replacing their cola and The food industry can be classified into two sub-
coffee consumption with more caffeinated energy categories: Agribusiness and processed foods. The
drinks. Smaller players like Hansen Natural (makers of agribusiness companies concentrate on early stages of
Monster), Red Bull, and Rockstar dominate the energy food production and engage in activities like harvesting,
drinks sector. milling, and processing raw material commodities.
Large agribusiness companies include Archer Daniels,
Bottled water Bunge Ltd, Corn Production Ltd., and the world’s
largest privately owned Cargill Inc. these companies
Bottled water contributes 27% of the total US beverage process and merchandize raw grains and supply end
consumption. The sector has seen two interesting products like oils, syrups, meals, and corn syrups to
trends in 2008. One is the decline in the sales for processed and packaged food and beverage
bottled water. This is largely because in the financial companies.
crisis, consumers are going back to tap water, and also
because of increasing awareness about environmental The other category is food manufacturers or food
hazards of plastic bottles. Secondly, because there is packagers, and includes Kellogg Co, PepsiCo, HJ
little or no differentiation among the products offered, Heinz Co, General Mills, Kraft Foods, and Campbell
consumers are buying less expensive generic brands. Soup. These companies sell finished goods to retailers
who then sell these goods to end consumers.
Overall, we will witness a number of new beverage
introductions in 2009, including the zero-calorie Most players in the food and beverage industry are very
compound Rebiana. Coca-Cola will launch its brand large global players, with big cash flows and deep
Truvia, and Pepsi will launch Purevia. pockets. They also have established brand names and
developed product categories. Entry into the sector is
International business largely prohibitive because a new entrant will not only
need a large production system, but will also need an
The packaged food industry in the US generates more extensive distribution network and sales and marketing
than two-thirds of its revenue from domestic sales. capabilities.
Packaged food is therefore less dependent than
beverage companies on foreign markets. This protects These large companies also have strong buying
it from volatility in international business. capabilities; therefore they manage to buy raw material
at cheaper prices as well as lock these prices against
On the other hand, beverage companies like Coca-Cola volatility. A new entrant or a smaller player does not
and PepsiCo get a major portion of their revenue from enjoy such capabilities and therefore cannot compete
overseas operations. Both companies see reduction in with the established players.
profitability whenever the dollar gets stronger and
foreign demand fluctuates. The main distribution channels for retail sales are
supermarkets, mass merchandisers, vending machines,
However, both the packaged food and beverage convenience stores, and other outlets including
sectors are increasing their promotion of global sales groceries and drug stores.

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 THE UNIVERSITY OF IOWA
Henry Fund Research Henry B. Tippie School of Management

With the kind of food that the average US consumer
purchases to eat at home, the importance of traditional
grocery stores has declined recently. The non-
traditional stores like supermarkets and warehouse
clubs have grown both in numbers and in total share of
the consumer food and beverage spending.
Acquisitions: acquisition of other businesses has been
the most reliable process for growth in the food and
beverage industry over the last 3 decades. With an
objective to grow fast, the F&B companies acquired
several unrelated businesses in the 70s and 80s.
However, they have restricted their acquisition spree in
the last 2 decades to related area of business. Most of
the recent acquisitions have been in a similar line of
business that complemented the acquirer’s existing
business line. The latest acquisition was privately-held
Mars Inc. acquiring WM Wrigley in Oct ’08.
even the food and beverage industry will get hurt badly.
One positive, though, is that in recession the
consumers will move their food and beverage habits to
less expensive and generic brands. Most of these
generic brands are owned by large retailers who
outsource the manufacturing to traditional food and
beverage manufacturers. Thus, while food-
manufacturing companies may witness lower sales of
their own brand, they will tend to recover some part of
their lost revenue through increased revenue from
generic brand companies.

Major recent acquisitions

Value
Acquirer Target (Bl $) Date
Mars Inc Wrigley 22.00 Oct'08
PepsiCo JSC Lebedyansky 1.40 Oct'08
Source: inflationdata.com
Kraft Foods' post
Ralcorp cereal business 1.65 Aug'08 In addition to problems faced due to difficult economic
ConAgra Foods' conditions, inflation in the economy has further
Osprale commodity trading 2.10 Jun'07 increased problems for consumers. As per data by the
Kraft Danone biscuit US Department of Labor, in the year 2008, retail food
prices increased by 5.8%. The producer price index for
Foods business 7.70 Nov'07
the food-finished goods declined by 150bps, whereas
Nestle Gerber 7.70 Aug'07 the producer price index for the entire economy was up
Coca- Energy Brands by 20 bps. The producer prices in the food & beverage
Cola (Glaceau) 4.10 Jun'07 industry is expected to decline in 2009, which will
Pilgrim's provide growth opportunities to the sector.
Pride Gold Kist Inc 1.10 Jan'07
Producer Price Index
Kraft United Biscuits
Foods (Spain) 1.07 Sep'06
Source: Standard and Poor’s industry report

ECONOMIC OUTLOOK
While the current economic condition is not promising
for the entire industry, consumer staples, in general,
and food and beverage, specifically, is expected to be
hurt the least because of the economic meltdown.
Traditionally, the sector has been recession-resistant.
This is because even in the economic slowdown,
consumers will not stop eating food. In fact, consumers
may sacrifice other products, including basic and luxury
products, but food and beverage is usually the last Source: United States Department of Agriculture data
sector hurt. Another positive aspect for the food and beverage
industry is reduced commodity prices. The All Crops
However, while food and beverage is recession Index of Prices Received by the US Department of
resistant, it is not recession proof. If the recession hits Commerce showcased earlier that commodity prices
the economy too hard and inflation becomes very high, were extremely volatile in 2008, ranging from 158

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Henry Fund Research
points in Jan. ’08 to 183 points in June ’08 and then
declining to 157 points in Jan. ’09. Volatality, especially
when the prices are falling, can be a problem for large
manufacturers, who lock in purchase price ahead of
time. However, in the long run, reducing prices of crops
that are the main raw materials for the food and
beverage industry will further boost profitability. At the
same time, if there is substantial increase in commodity
prices, profitability in the industry will suffer.
Another problem for all industries that have heavy
international business, and for the food and beverage
industry specifically, is strengthening of the dollar. Most
of the large food and beverage companies have a
significant international presence. Inprovement in the
dollar in relation to other global currencies means lower
in-dollar revenues from international operations. As
indicated in the following chart, from a peak of 1.6
dollars to one euro in Feb. ’08, the current prices are
1.31 euros to a dollar. Yen to dollar rates are no
exception and have moved from 110 yen/dollar in Jan.
’08 to 88 yen/dollar in Jan. ’09.
Yen/Dollar
CATALYSTS FOR GROWTH
The food and beverage industry is likely to outpace the
growth of many industries in the coming year. The
major catalysts for domestic growth include higher
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THE UNIVERSITY OF IOWA
Henry B. Tippie School of Management
demand for packaged food because of changing
lifestyles and less time available for cooking food.
Consciousness for healthier food, with high nutritional
value, high fiber content, organic food, or natural food
will be another driver for growth.
The economic condition in developing markets is
growing at a fast pace, along with a strong preference
for packaged food. The disposable income growth and
population explosion are other important factors for
impetus in demand in emerging economies. Stronger
demand from overseas operations will be one of the
biggest growth opportunities for food and beverage
companies.
INVESTMENT POSITIVES

The consumer staple sector generally has low
sensitivity to recession. Food and beverage
companies are affected less by economic slowdown.
The current economic crisis will offer the food and
beverage sector as an investment haven when all
other sectors are bleeding red.

Most companies in the food and beverage sector are
corporations with stable cash flows and deep
pockets. Even if the recession continues for a long
time, these large companies have the strength to
withstand the slowdown.

The current trend of reduction in commodity prices
promises higher profitability in the sector.

We will witness increased demand for healthy and
organic food, which are expected to be high-margin
products.

The ever-increasing baby-boomer population will
demand healthier and more nutritional products.

The demand for packaged food from developing
nations, especially in Europe and Asia, continues to
be strong. Changing lifestyle, stressful work
environment, less available time, double-income
families, and demand for healthy and handy
packaged food will propel growth for food and
beverage companies.

Once the economy sees some sign of stabilization,
the current rock-bottom interest rates will trigger a
spree of M&A activities in the sector.
INVESTMENT NEGATIVES

The meltdown in the global economy has hit all
industries, including food and beverage. If the trend
continues, even this sector will get a powerful blow.
 THE UNIVERSITY OF IOWA
Henry Fund Research Henry B. Tippie School of Management

If the bio-fuel movement picks up, commodity prices IMPORTANT DISCLAIMER

will soar. This will increase the raw material cost for
food and beverage companies, which they will be This report was created by a student(s) enrolled in the
forced to pass on to customers. Applied Securities Management (Henry Fund) program
at the University of Iowa’s Tippie School of

A stronger US dollar will erode a large part of the Management. The intent of these reports is to provide
revenue earned in the foreign markets. The new US potential employers and other interested parties an
government has proposed a change in tax example of the analytical skills, investment knowledge,
regulation. The new regulation, if implemented will and communication abilities of Henry Fund students.
tax the overseas income of US corporations Henry Fund analysts are not registered investment
immediately, against the past practice of levying advisors, brokers or officially licensed financial
taxes when the income is brought back to US. The professionals. The investment opinion contained in this
new proposed, if implemented, will have a severe report does not represent an offer or solicitation to buy
negative impact on f&b companies most of which or sell any of the aforementioned securities. Unless
have large overseas operations. otherwise noted, facts and figures included in this report
are from publicly available sources. This report is not a
complete compilation of data, and its accuracy is not
REFERENCES guaranteed. From time to time, the University of Iowa,
1. http://www.forecast-chart.com/ its faculty, staff, students, or the Henry Fund may hold a
2. http://www.bls.gov/ financial interest in the companies mentioned in this
3. http://www.beverageworld.com/ report.
4. http://www.beverage-digest.com/
5. http://www.USDA.gov
6. http://www.commerce.gov
7. http://finance.yahoo.com
8. http://inflationdata.com/Inflation/Consumer_Price_Ind
ex/HistoricalCPI.aspx
9. http://usrecessions.com/index.php
10. http://www.preparedfoods.com/
11. http://usda.mannlib.cornell.edu/usda/current/AgriPric/
AgriPric-01-30-2009.pdf
12. Standard and Poor’s NetAdvantage. “Industry Trends:
Foods & Nonalcoholic Beverages.”
13. Association of Food Industries, Inc.